WFE comments to IFAC on exchange prices

WFE comments to IFAC on exchange prices

WFE has responded to a public inquiry by the International Federation of Accountants on valuing complex financial instruments.  Not all markets are the same.  An organized, regulated market provides access for all kinds of actors to submit bid and ask prices for securities, and for the market depth to be seen in the trading book.   The experience of the last two years shows the point:  OTC largely froze up, while exchanges maintained their operations.  Accountants should give preference to the public market price.

Below is the WFE comment to IFAC on exchange pricing.



Mr. Arnold Schilder,


International Audit and Assurance Standards Board

c/o IFAC


23 December 2009 


Ref :  Request for comment on auditing complex financial instruments (IAPS 1012)


Dear Arnold, 

World Federation of Exchanges Chairman William J. Brodsky joins me in thanking the IAASB for holding a public consultation on the subject of auditing complex financial instruments.  This question is fundamental for the world’s capital markets, exchanges included.   

WFE supports the direction for audit indicated in paragraph 13 of the IAASB consultation paper.   The IAASB should update its approach to complex instruments, as the paper states. Before that is done, it would be useful to give additional guidance to auditors by basing work on advances made in the UK, as the IAASB paper proposes. This would signify progress in a difficult area of financial accounting, and it would establish a consistent approach worldwide.  

WFE also wishes to comment on paragraph 33 of the consultation paper. Our remarks concern what IAASB means when fair value for such instruments is considered “a quoted market price,” as compared to when estimates or other methods are used for accounts. The meaning of “a quoted market price” has come up in the IAASB’s Consultative Advisory Group on a few occasions since WFE joined in 2002, without being formally resolved, if I recall correctly.  

The IAASB public inquiry does not include a more explicit definition of fair value, and neither does the IAASB 2009 “Handbook of International Standards on Auditing and Quality Control.”  WFE supports the paper’s suggested use of market prices, when available, as the fair value. But there are many sorts of “market prices,” a broad point for auditors to keep in mind. WFE strongly encourages the accounting profession to study this concept further. 

Exchanges operate organized, regulated platforms for prices to be discovered through transparent processes where buyers and sellers interact.  The prices of exchange-traded instruments reflect this buying and selling interest; and even when trading volumes get thin, that drop-off in interest is reflected in bid/ask spreads and a less deep order book.  Transaction prices, spreads, and the trading book together convey the public market. 

Exchange prices are more reliable and more current than prices established over-the-counter. OTC can mean pricing established by an unknown number of firms, perhaps just a few traders, and sometimes just one firm.  Orders are often internalized within large firms. These other forms of transacting must not be confused with regulated exchange trading. The problem is in the wording, because all these transactions are characterized as taking place “on a market.” Furthermore, the reporting entity often has a vested interest in the price being selected. 

The ongoing financial crisis post-2007 has underscored the qualitative distinction between exchange pricing and other markets. From July-August 2007 onwards, entire OTC segments stopped functioning while exchanges continued their operations.  WFE suggests that preparers of financial statements and their auditors should be required to look to exchange prices, whenever available, to establish and validate financial accounts for securities and futures instruments.  

On complex instruments, the specific point of this inquiry, exchange prices can also frequently be used to derive estimates for fair value.  Theoretical prices for customized products can often be created by breaking down the complex instrument into a series of listed options or futures, weighted by standard expiry dates.  As I understand it, this is roughly how investment banks create such instruments, and how they hedge their position risks during the lifetime of these products.  

Most complex financial instruments are likely to be related (correlated) to the tens of thousands of securities and derivatives contracts already listed and traded on exchanges.  By requiring the preparer of financial statements to use exchange prices, whenever possible, management would have more accurate position information; and the auditor’s verification would have a sounder basis for this estimate.  

In conclusion, exchanges are not just any market. The prices established on them result from the public exposure of buying and selling interest from multiple sources. For determining fair value, financial reporting would be more informative and reliable if accounting practice made an explicit distinction between estimates of fair value based on prices established in public exchange markets and those based on less transparent transactions. 

Please contact me if you have any questions on this matter.    


Thomas Krantz

Secretary General

World Federation of Exchanges